Why Google's tax rate was higher

Analysis: Investors should listen to company, not analysts

By

JohnShinal

SAN FRANCISCO (MarketWatch) -- Investors who were surprised by Google Inc.'s fourth-quarter earnings miss may have forgotten that the search giant is a young company still learning how to run its business.

They might also remember that this was not the first time Google didn't hit Wall Street's numbers.

Chief Financial Officer George Reyes said on a conference call late Tuesday that "most of the (earnings) miss" was due to Google's tax rate being much higher than expected.

The reasons behind the higher tax rate, however, raise the question of how well Google is managing its rapid growth?

Google spent more on its non-U.S. operations than it expected in the fourth quarter as it rolled out new services across the globe.

Or, as Reyes put it on the call, "a portion of expenses allocated to international operations was greater than we expected."

At the same time, due to unfavorable currency exchange rates, the percentage of total revenue that Google derived from its non-U.S. business ticked down to 38%, from 39% in the third quarter.

That combination -- higher expenses and a lower revenue contribution -- caused Google's international business to contribute less to the firm's overall operating profit than Google expected.

That, in turn, meant that Google derived a greater percentage of its operating profit from its U.S. operations -- which are taxed at a higher rate.

Add it all up, and Google had a fourth-quarter tax burden of 41.8% -- which pushed its annual tax rate to 31.6%, above the 30% rate Google expected

To be sure, Reyes can't help that the U.S. dollar stayed strong against other currencies, which depressed overseas sales figures. And his honesty about the higher tax rate was downright refreshing.

"These estimates are complex," Reyes said on the conference call.

Still, if the CFO doesn't have a handle on the tax stuff, or didn't hedge Google's currency risk properly, who exactly is minding the cash register over in Mountain View?

Google's operating margin was less than expected by analysts, and its hiring rush has given even bullish analysts like Morgan Stanley's Mary Meeker reason to pause.

"The rapid growth in headcount bears watching," Meeker, who rates the stock overweight, wrote in a report to clients Wednesday.

Missed numbers, missed irony

The ironic thing about Google shares selling off after the company missed analyst estimates is that it was the company's defiant attitude toward Wall Street that so enamored retail investors in the first place.

Google founders Sergey Brin and Larry Page have said repeatedly that they wouldn't give forecasts for the sake of stock research analysts. Google has stuck to that pledge, thereby forcing analysts to calculate sales and profit estimates without the aid of company guidance.

Mom and pop investors, who got burned by misleading analyst research during the late 1990's stock boom, loved that kind of talk. That kind of devotion, along with Google's awesome ability to generate cash, is why the stock has risen more than fourfold since its August 2004 IPO.

This isn't the first time Google didn't hit the profit figure estimated by Wall Street analysts -- in fact, it's repeatedly exceeded even the loftiest expectations quarter after quarter.

But no one cared that Google wasn't on the same page as the analysts, of course, because those "misses" were on the upside.

Now that Google has missed on the low side, thanks to some sloppy tax planning, professional investors have noticed.

"For the next quarter or two, Google will need to prove itself again," said Romeo Dator, co-manager of the All-American Equity Fund for U.S. Global Investors in San Antonio.

The fund sold two-thirds of its shares in the last few months before the earnings report, according to Dator.

Those sales came despite the fact that Wall Street analysts have a median price target on Google shares of $490. Individual investors may want to remember that it's those analysts -- and not the company itself -- who said Google would earn $1.76 a share this quarter.

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